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Surge In Japanese Yen Could Signal Faltering U.S. And Global Economies, Goldman Sachs Says USD/JPY To Be 130 By Year-End?

by Ed Wijaranakula, NMS Invesment Research

The USD/JPY exchange rate continues to head lower, despite a brief rebound from the February 11 low of 110.98 yen per dollar, when Federal Reserve Chair Janet Yellen told the U.S. Congress during her two-day testimony that overseas weakness and market distress could threaten the Fed's plans to raise the rate gradually this year. Ms. Yellen, however, didn't explicitly mention any delays to interest rate hikes during her testimony, meaning a March rate hike may be still on the table.

Concerns about weakening global economies and aggressive Fed rate hikes put buying pressures on the Japanese yen as a safe-haven currency. The fx currency traders have shrugged off the possibility that Japan's economy could fall back into recession, considering that the Cabinet Office of Japan said last week that Japan's GDP shrank an annualized 1.4% in the fourth-quarter ending December 31, 2015, as weakness in private consumption persists.

The U.S. economy doesn't fare much better since the U.S. manufacturing sector is showing signs of losing more momentum. The flash manufacturing purchasing managers index, PMI, from Markit, released on Monday, fell to 51.0 from 52.4 in January, the lowest reading since September 2009. Economists had been expecting a reading of 52.5, according to MarketWatch. A PMI reading above 50 indicates expansion in the sector.

The minutes from the Federal Open Market Committee (FOMC) meeting in January, released last Wednesday, revealed that the Fed considered changing their planned path of interest rate hikes in 2016, as tighter global financial conditions could hit the U.S. economy. Nearly 68% of economists surveyed by Bloomberg now say that the Fed's next rate hike will be at the FOMC meeting in June. In January, only 30% of those surveyed had thought that the Fed would increase in June, with the majority believing in a March rate hike.

One of the U.S. Federal Reserve's most prominent advocates of higher interest rates, James Bullard, the president of the Federal Reserve Bank of St. Louis, declared on Wednesday that it was "unwise" to move any further in light of weak inflation and global volatility, suggesting the Fed is stepping further away from plans to continue to hike rates, said Reuters.

As of February 16, there were 53,947 short positions of Japanese yen, traded on the Chicago Mercantile Exchange, CME, in units of 12,500,000 Japanese yen, by leveraged funds, a decrease of 2,949 contracts from the previous week, according to the Commitment of Traders, COT, data released by the Commodity Futures Trading Commission, CFTC. This is compared to about 69,256 long positions, an increase of 6,915 contracts during the same period.

The CFTC data suggests that the hedge funds have been increasing their long positions and cutting back on their short positions of Japanese yen, resulting in an increase in the net long positions by 9,864 contracts, worth about 123 billion yen.

According to Bloomberg, Goldman Sachs is unconvinced that yen strength will be sustained, as its chief currency strategist Robin Brooks wrote in a note to clients last Friday that the bank sees the yen weakening to 120 yen per dollar "in the near term" and 130 yen per dollar by year-end. The median of more than 50 estimates compiled by Bloomberg calls for the yen to slump to 120 yen per dollar by the end of March, and to 123 yen per dollar by year-end.

USD/JPY Technical Chart

From our long-term technical viewpoint, the USD/JPY broke down a bearish ascending wedge chart pattern earlier this year and the objective price target is around 100 yen per dollar. In the near-term, the bearish sentiment has increased significantly, as the currency pair broke the neckline support of the head and shoulders chart pattern at the 116 yen per dollar level. It is likely that the USD/JPY will retest the 110.98 yen per dollar level and eventually move downward towards the 106.63 yen per dollar level, or 38.3 Fibonacci retracement.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.